In a world where currencies dance like chess pieces on a global stage, the US dollar has long reigned as king. Amidst the ebb and flow of market currents, whispers of change have begun to swirl, hinting at a tectonic shift that could dethrone the mighty greenback from its holy position. A captivating tale of power and ambition unfolds as nations gather and alliances form. While de-dollarization wasn’t much of a hot debate years ago, more and more people are discussing the tectonic shift that could overthrow the mighty dollar. The question then becomes, is de-dollarization the reason behind the fall in the US dollar’s value?
De-dollarization is reducing reliance on the US dollar as a global reserve currency. It involves countries shifting away from using the dollar in their financial transactions, trade agreements, and foreign exchange reserves. Instead, they adopt other currencies or assets such as the euro, the Chinese yuan, gold, or other currencies. The idea behind de-dollarization is to decrease the dependence on the US dollar and its influence on the global economy.
World leaders, from France’s Emmanuel Macron to Brazil’s Luiz Inacio Lula da Silva, are increasingly engaging in diplomatic chess moves, seeking alternative alliances and international financial arrangements. At the same time, the Chinese yuan and the Russian ruble stand ready to take a more prominent role in the trillion transactions that occur every year in international trade (with the majority of them being in US dollars). Several political moves have fueled the discussion, including meetings between various presidents and Chinese President Xi Jinping and the most recent deal between China and Brazil to settle trades in their own currencies rather than dollars. When Mr. da Silva visited China, he stated, “Every night I ask myself why every country needs to trade in the dollar” 1.
While the idea of US de-dollarization might be quite appealing to US competitors like Russia and China, which would give them far more leverage in terms of their role in the world economy, according to most, there’s a long way for the US dollar to be dethroned. There are two separate concepts to consider: the dollar’s value, compared to other currencies, and its role as the global reserve currency. While its value has dipped recently, it’s still stronger than it has been for most of this century. The recent dip in the US dollar value is not necessarily associated with a fall in currency reserves. Instead, multiple other factors have contributed to the fall in the US dollar value.
The US dollar has experienced a decade-long bull market, and it does still remain close to a 10-year high compared to the other currencies the US dollar trades with. In the chart below from Yahoo Finance, you can see the US dollar index. This index tracks the greenback’s value against some of the world’s most important currencies. As you can see, up until recently, the US dollar has been enjoying the bull ride. The main factors contributing to this are the interest rates that were relatively lower compared to other countries and a strong economic recovery from the 2008 financial crisis.
From 2015 onwards, the US dollar has increasingly been gaining value. That’s because the interest rates in major economies like Europe and Japan were near zero or negative. At the same time, the interest rate in the US was positive, generating way higher returns for investors. As markets are ruled by demand and supply, more appealing returns on US assets pushed the demand higher, contributing to the upward trend of the greenback you see above.
However, recently the story slightly shifted, and many analysts and investors see that there will be room for a moderate decline in the greenback’s value over the short term. The reason why the decline is expected is because many investors believe the ending of the interest rate hike by the Fed is near. The recent banking crisis has suggested that the US economy is not as strong as it used to appear, and many don’t believe that the economy can take another interest rate hike.
On the other hand, other central banks, such as the European and the UK central banks, have to keep their rates up due to scary inflation numbers, particularly in the UK. This allows for higher returns in these economies, weakening the demand for the US dollar. Therefore, the drop in the dollar value doesn’t necessarily mean that foreign currency reserves are falling and the demand for it to be a currency reserve is weakening.
Over the long term, the chance of a fall in US dollar dominance is present, and it benefits many emerging economies. Reserve status change can change over time, but it is unlikely that we will see a dramatic fall in the US dollar as the world’s leading currency reserve. That’s because the US has a far more advanced economy and is less fragile to economic and political turmoil when compared to other economies.
McMillan, who is the Chief Investment Officer for Commonwealth Financial Network, argues that there are three things that make the dollar so “special.” The size of the US economy, which only the yuan and euro can come anywhere close to, the freely convertible nature of the dollar, and the political and economic stability of the US compared to Europe and China.2
In conclusion, the whispers of de-dollarization and a potential shift in the global reserve currency status have been gaining momentum. Still, the US dollar’s reign remains predominantly unchallenged in the short term. The recent dip in the dollar’s value, driven by factors like the end of interest rate hikes by the Fed and higher returns in other economies, does not necessarily indicate a decline in its currency reserve status. Over the long term, the possibility of the US dollar’s dominance waning exists, which could benefit emerging economies. However, any dramatic fall in the dollar’s position as the world’s leading currency reserve is unlikely due to the US’s advanced economy and resilience to economic and political turmoil.